troysapp wrote:I’ve just finished reading “The Permanent Portfolio”, and I have a few questions and observations:
Thanks for reading the book [disclosure: I'm one of the authors]
1. On page 25 the returns of a 60/40 portfolio are compared to the Permanent Portfolio. Was the 60/40 portfolio rebalanced over the time period shown? Also, the book discusses storage, tax, insurance, and buying/selling commissions associated with owning gold. Taken together these expenses can be huge. Were these expenses considered when calculating the hypothetical Perm Portfolio return?
The 60/40 portfolio was chosen because it's kind of a "standard" in the industry in terms of simplicity and performance. The numbers assumed rebalanced each year. Because there are an infinite number of portfolio combinations one can select, we used the 60/40 because it is easy to implement and offers good performance compared to most of what the professional finance industry sells to people.
The expenses of the Permanent Portfolio are not actually huge at all. Gold is rarely rebalanced. Same for the other assets. Maybe in a big bull market you'll do it every few years or so. I have been running the portfolio for years and annual expenses are no worse than any other passive strategy I've seen or used in the past. I say this based on real-world experience because I eat my own dog food. Consider:
- Own a cheap broadly based index fund. Expense ratio is perhaps 0.10% a year now.
- Own your Treasury bonds directly so you don't use a fund. Expense ratio is 0%. Some brokerages even allow free trades to a certain amount.
- Own a cheap Treasury Money Market fund again with expense ratio well under 0.20%
- Own gold directly, with an ETF, or overseas if you want to go full monty. If you own it directly there is an initial cost, but after that you can store it at bank with a very cheap safe deposit box. If you own an ETF you pay around 0.30% or so if I recall. If you own overseas you may pay 1% a year or less depending on the value.
Taken altogether you can run the portfolio for under 0.30-0.40% total expenses. It can actually be done for probably less than 0.20% in many cases now.
2. Page 144 says “gold does best under high-inflation scenarios” and “in terms of purchasing power protection, gold has a long term track record that is unmatched”. Are these statements true? How long is “long term”? From the evidence I’ve seen it appears that gold tends to react favorably to inflationary environments, but not always.
That's going to stir up a huge debate here. I think when the chips are down and currencies are having a problem, or people think it's going to have a problem, you better be holding some hard assets. The hard asset that works best is gold because it is a monetary metal (that's why central banks own it themselves). I say this based on my experience in traveling to around 25 countries in my life and study of financial history in markets all over the planet where paper currencies had hiccups.
Gold is a fail-safe asset in the portfolio. It is not going to grow like stocks and bonds because it has no internal rate of return. I do not dispute this. What I do suggest though is that gold has a much different risk profile than stocks and bonds and this can aid tremendously for diversification. Especially if that diversification is needed in a crisis.
I think it's a really good idea to have some of your profits from stocks and bonds as well as other savings stored in a way that has a long history of surviving pretty hectic times. After all, sometimes stocks and bonds are not providing real after-inflation returns as has happened in the past. In that case, gold may be the only asset you have that's growing in excess of actual inflation. Not just this, but gold as an asset can be stored overseas as we discuss in the book to give you geographic diversification against natural or manmade disasters.
But mainly, gold is an insurance asset and also an asset that tends to do well when stocks and bonds are not. However, it can go into the doghouse as well and that's when the stocks and bonds can take up the slack historically speaking.
3. On page 226 VT is recommended for equity exposure, however on page 212 it’s written that “you should hold stocks mostly in the country where you live. The exception is if you live in a country with a very small economy and stock market.” How does one reconcile these recommendations? And what evidence is there to support holding overweight home country equity exposure?
Here's the deal about this. The Permanent Portfolio has a much different view on diversification than other approaches. Specifically, it is tied to economics and monetary policy in a world run by politicians and central banks (which leads to prosperity, inflation, recession, and deflation). These policies greatly affect the markets of each country individually
. In effect, I think it is silly to say "The World is Flat" as has become recent mantra. A bad economy in the U.S. does not mean a bad economy in Australia for instance. Likewise, buying a bunch of stocks in Brazil because someone said it's the great thing coming overlooks very real risks compared to investing in a more stable and far less corrupt stock market like the U.S.
Finally, if you are in the U.S. you have a huge presence all over the planet already because U.S. companies still dominate. I can go to any country on this planet and I probably flew there in a Boing Jet. The locals are driving American cars in many places. They are drinking Coca Cola. They are on the Internet with Cisco routers and Dell Computers running Microsoft Windows. They go down to Starbucks wearing their Nikes. Etc. So for a U.S. investor there is not as strong a case for international exposure. IMO.
But with the above said, if you wanted to punt and just own domestic and international I think that the Vanguard Total (VT) fund that owns both US and International is a good way to do it. Even then, owning a lot of international opens you up to currency risk so that's always with you.
5. Finally, the book examines returns back to the beginning of 1972. To me this seems much too short of time to come to any conclusions (for example, most of this time was during the great bull bond market). I also realize that US gold price info for the nearly 40 years pre-1971 is not available (or necessarily good), but if foreign gold prices are available it would be useful to have a longer examination of the Perm Portfolio characteristics.
Prior to 1972 the U.S. was on a gold standard so comparisons back before that date can be a problem. Internationally gold was a fixed price so comparing it across markets also would not be fruitful. With that said, Harry Browne and his team in the 1970s looked at a lot of data and financial history when designing the portfolio strategy. Sometimes data alone can't tell you enough though. And truth be told, I really think backtesting has limited usefulness because it can only show you what worked in the past, not what will work going forward. At that point it's going to come down to economic analysis and testing theories by analyzing extreme events and movements of capital to see what blew up and what didn't (and why).
As a side, the book also recommends holding gold in offshore accounts. I’m personally acquainted with a person that held approx $5m (or approx 5% of his net worth) of gold bars in an Italian vault. Early 2009, when things appeared their worst, he decided to have the gold bars shipped from Italy to the US. The shipping, security, and marine insurance costs were huge. His now deceased father originally purchased the gold in the early 1970s (and probably held offshore since he was worried about the US government calling gold stores again), but when things went bad he wanted his gold close by.
I don't have any input on storing gold in Italy. In the book we recommend people looking to store gold overseas only deal with countries that are stable, first-world, and have a history of respecting the private property of their citizens. I'm not sure I'd put Italy in all three categories so I'd avoid it personally. I think there are better places to consider first.
But even then, things change. The point of the geographic diversification is to give you options to deal with extraordinary events. In that way, it's providing another level of diversification for investors to consider.
All-in-all the “Permanent Portfolio” is a very interesting theory. A sort of "barbell" approach. I’m just not yet convinced that it’s the right approach for me.
And it may not be. The book presents a lot of ideas that we know people may pick and choose from for their own use. I think the portfolio is really good for people that:
1) Want stability and low volatility.
2) Will be happy with moderate returns instead of swinging for the fences.
3) Want wide and strong diversification against potentially serious market events.
4) Don't want to watch their portfolios very often yet still know it is growing safely.
With that said, if someone wants they can run a Variable Portfolio alongside their Permanent Portfolio for money they can afford to lose. So that's where I recommend people normally put more stocks, etc. if they want to try to goose returns (realizing it may not always work).
Thanks again for reading the book.